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Why Agency Costs Explain Diversification Discounts

Author

Listed:
  • Cronqvist, Henrik

    (Graduate School of Business)

  • Högfeldt, Peter

    (Department of Finance, Stockholm School of Economics)

  • Nilsson, Mattias

    (Department of Finance, Stockholm School of Economics)

Abstract

We study diversification within the real estate industry because of its relative transparency: portfolio management of assets with well-defined market prices. Diversification is over property types and geographical regions. The major cause of the diversification discount is not diversification per se but anticipated costs due to rent dissipation in future diversifying acquisitions. Firms expected to pursue non-focusing strategies do indeed diversify more, are valued ex ante at a 20% discount over firms anticipated to follow a focusing strategy, are predominantly privately controlled and extensively using dual-class shares. The ex ante diversification discount is, therefore, a measure of agency costs.

Suggested Citation

  • Cronqvist, Henrik & Högfeldt, Peter & Nilsson, Mattias, 1999. "Why Agency Costs Explain Diversification Discounts," SSE/EFI Working Paper Series in Economics and Finance 294, Stockholm School of Economics, revised 27 Sep 2000.
    • Handle: RePEc:hhs:hastef:0294
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    Cited by:

    1. Zhilan Feng & Maneechit Pattanapanchai & S. McKay Price & C. F. Sirmans, 2021. "Geographic diversification in real estate investment trusts," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 49(1), pages 267-286, March.
    2. Chen Zheng & David Ling & Gianluca Marcato, 2018. "Do Property Locations Matter to IPO Valuation? Evidence from U.S. REITs," ERES eres2018_299, European Real Estate Society (ERES).
    3. Chongyu Wang & Tingyu Zhou, 2021. "Trade-offs between Asset Location and Proximity to Home: Evidence from REIT Property Sell-offs," The Journal of Real Estate Finance and Economics, Springer, vol. 63(1), pages 82-121, July.
    4. Dick Boer & Dirk Brounen & Hans Op’t Veld, 2005. "Corporate Focus and Stock Performance International Evidence from Listed Property Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 31(3), pages 263-281, November.
    5. David C. Ling & Chongyu Wang & Tingyu Zhou, 2021. "Institutional common ownership and firm value: Evidence from real estate investment trusts," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 49(1), pages 187-223, March.
    6. David C. Ling & Gianluca Marcato & Chen Zheng, 2022. "Does asset location and concentration explain REIT IPO valuation?," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 50(3), pages 672-706, September.
    7. Kreppmeier, Julia & Laschinger, Ralf & Steininger, Bertram I. & Dorfleitner, Gregor, 2023. "Real estate security token offerings and the secondary market: Driven by crypto hype or fundamentals?," Journal of Banking & Finance, Elsevier, vol. 154(C).
    8. Kevin Beaubrun‐Diant & Tristan‐Pierre Maury, 2022. "Corporate focus, residential assets, and the performance of French REITs," Bulletin of Economic Research, Wiley Blackwell, vol. 74(2), pages 599-621, April.
    9. James Chong & Alexandra Krystalogianni & Simon Stevenson, "undated". "Dynamic Correlations across REIT Sub-Sectors," Real Estate & Planning Working Papers rep-wp2011-07, Henley Business School, University of Reading.
    10. Daniel Broxterman & Tingyu Zhou, 2023. "Information Frictions in Real Estate Markets: Recent Evidence and Issues," The Journal of Real Estate Finance and Economics, Springer, vol. 66(2), pages 203-298, February.
    11. Farooqi, Javeria & Harris, Oneil & Ngo, Thanh, 2014. "Corporate diversification, real activities manipulation, and firm value," Journal of Multinational Financial Management, Elsevier, vol. 27(C), pages 130-151.
    12. Kreppmeier, Julia & Laschinger, Ralf & Steininger, Bertram & Dorfleitner, Gregor, 2023. "Real Estate Security Token Offerings and the Secondary Market: Driven by Crypto Hype or Fundamentals?," Working Paper Series 23/6, Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance.
    13. David Burnie & Adri De Ridder, 2009. "Bear Market Behavior of Institutional Investors in Sweden," American Journal of Business, Emerald Group Publishing Limited, vol. 24(1), pages 33-46, April.
    14. SeungHan Ro & Alan Ziobrowski, 2011. "Does Focus Really Matter? Specialized vs. Diversified REITs," The Journal of Real Estate Finance and Economics, Springer, vol. 42(1), pages 68-83, January.
    15. Holmen, Martin & Hogfeldt, Peter, 2004. "A law and finance analysis of initial public offerings," Journal of Financial Intermediation, Elsevier, vol. 13(3), pages 324-358, July.
    16. Nicolas Kohl & Wolfgang Schaefers, 2012. "Corporate Governance and Market Valuation of Publicly Traded Real Estate Companies: Evidence from Europe," The Journal of Real Estate Finance and Economics, Springer, vol. 44(3), pages 362-393, April.
    17. Avis Devine & Isabelle Jolin & Nils Kok & Erkan Yönder, 2024. "How Gender Diversity Shapes Cities: Evidence from Risk Management Decisions in REITs," Journal of Business Ethics, Springer, vol. 189(4), pages 723-741, February.
    18. Hartzell, Jay C. & Sun, Libo & Titman, Sheridan, 2014. "Institutional investors as monitors of corporate diversification decisions: Evidence from real estate investment trusts," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 61-72.
    19. James Chong & Alexandra Krystalogianni & Simon Stevenson, 2012. "Dynamic correlations between REIT sub-sectors and the implications for diversification," Applied Financial Economics, Taylor & Francis Journals, vol. 22(13), pages 1089-1109, July.
    20. Eli Beracha & Zifeng Feng & William G. Hardin, 2019. "REIT Operational Efficiency: Performance, Risk, and Return," The Journal of Real Estate Finance and Economics, Springer, vol. 58(3), pages 408-437, April.

    More about this item

    Keywords

    Diversification; Diversifying strategy; Ex ante discounts; Rent dissipation; Agency costs; Private control;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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